By Jemima Kelly

LONDON (Reuters) – Sterling skidded to its lowest levels – bar a “flash crash” in October – in 32 years on Monday, hit by fears that Prime Minister Theresa May will say on Tuesday that Britain is set for a “hard” Brexit out of the EU and its single market.

Sterling fell as much as 1.5 percent against the dollar and 2.5 percent against the yen. That shifted the spotlight away from the greenback, which has come under pressure in recent days as investors ponder U.S. President-elect Donald Trump’s likely economic policies after he takes office on Friday.

The pound plunged to $1.1983 <GBP=D4> in early trade in Asia, depths not seen since a bout of thin liquidity triggered a “flash crash” on Oct. 7 that wiped as much as 10 percent off the pound in a matter of minutes. Apart from that, it was the lowest level since May 1985.

By 1230 GMT (7:30 a.m. ET) sterling had managed to climb back above $1.20, but was still trading down more than 1 percent on the day at $1.204.

Dealers said the market was reacting to various media reports over the weekend that said May would signal plans for a “hard” Brexit in her speech on Tuesday, saying she’s willing to quit the European Union’s single market in order to regain control of Britain’s borders.

“Every time there’s ‘hard Brexit’ headlines, that triggers a fresh bout of selling sterling,” said MUFG currency analyst Lee Hardman, in London. “It’s almost impossible to see Europe allowing the UK to remain a full member of the single market if it wants to regain control of the border and the laws and wants to strike its own agreements.”

Hardman added that the weekend reports were “not really new news”, as May’s government has consistently pointed toward giving priority to immigration controls over single market access, and that was why sterling had not fallen further in London trading hours.

U.S. markets were closed on Monday for Martin Luther King day, which means liquidity will be lower.

“The fact that the sell-offs usually happen during periods in which there’s less liquidity increases the risk we could have a sharper sell-off (today), but as we saw in the flash crash that doesn’t mean that’s fundamentally justified,” said Hardman.

Citi’s head of European G10 currency strategy in London, Richard Cochinos, said Britain’s hefty current account and budget deficits meant it was heavily dependent on foreign capital. The more uncertainty investors feel over Britain’s place in Europe, he said, the more investment dries up – the key reason for sterling’s weakness.

May has said she will trigger Article 50 – starting the formal EU withdrawal talks – by the end of March. But so far, she has revealed few details about what kind of deal she will seek, frustrating some investors, businesses and lawmakers.

“SAFE-HAVEN” YEN

The euro climbed as much as 1.5 percent against the pound to a two-month high of 88.53 pence <EURGBP=>, before retreating to 87.85 pence, still up 0.7 percent on the day.

Against the yen, which is perceived as a safe haven, sterling fell as much as 2.3 percent to a two-month low of 136.48 yen <GBPJPY=>, before recovering to trade down around 1.4 percent on the day by 1230 GMT.

The Japanese currency gained broadly as a risk-off mood permeated markets, hitting a six-week high of 113.61 yen to the U.S. dollar <JPY=>.

“The risk-averse sentiment stemming from ‘hard Brexit’ (worries) is pushing down the dollar/yen,” Masafumi Yamamoto, chief forex strategist at Mizuho Securities in Tokyo.

“But so far, I think the correction from the dollar/yen’s high in December, and concerns about stronger protectionism under the new U.S. presidency, have been the dominant theme.”

The dollar index climbed 0.4 percent to 101.59 <.DXY>.

Trump revealed few policy clues at his first press conference last week since his November election victory. The dollar rose after the election on expectations that his administration would embark on stimulus to boost growth and inflation, prompting the U.S. Federal Reserve to adopt a faster pace of interest rate hikes.

But Trump’s protectionist stance has also added to some investors’ risk aversion, as he has threatened to impose retaliatory tariffs on China, build a wall along the Mexican border and tear up the North American Free Trade Agreement (NAFTA).

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets

(Additional reporting by Wayne Cole in Sydney and Tokyo markets team; Editing by Catherine Evans)